When selling a family business, one of the single greatest expenses will be taxes.
That’s why careful planning is so important. Now, because of a new law that quietly took effect in December 1999, taxes will be an even greater burden on many business sales. Without proper planning and structuring, many owners may find it nearly impossible to meet the tax burden of selling a closely held business.
“Before the law took effect, sales that involved the transfer of a business’s assets (which is the way many business sales are structured) would fall under the installment sales rules,” explains Roger Lossing, family wealth advisor with Bank One Investment Advisors. These rules allowed the seller to spread out his or her tax burden over the course of the purchaser’s installment payments. So, taxes were due as the installments were received from the purchaser.
But that all changed in December 1999. Now, if the sale is structured as a sale of the business’s assets, the business owner must pay all of the tax on the sale up front, even though he or she will receive payments from the purchaser over a number of years.
This legislation took a lot of people by surprise, and many business owners simply don’t have the assets to pay such a large tax bill all at once. There is, however, a growing movement to repeal this ruling.
Fortunately, there still are ways to take advantage of the installment sales rules, but they involve careful planning long before a sale takes place.
For example, if the sale of the business involves the sale of stock, as opposed to the sale of assets, the owner can take advantage of the installment sales rules and defer the taxable gain, Lossing says. But this is something that has to be planned for by the owner, and agreed to by the purchaser, in advance of the transaction.
Some of the primary goals within the sale of a family business are to minimize the impact of taxes by spreading them over a long period of time. Additionally, helping the family achieve their wealth-preservation goals is paramount to a successful transaction.
With these goals in mind, consider either a corporate restructuring or recapitalization to reduce the tax bite.
In general, these efforts involve implementing either a gain reduction strategy that alters the ownership structure of the company to reduce taxes, or a gain deferral strategy that defers the gain over a long-term basis, typically through the use of an ESOP.
ESOPs are increasingly popular with owners of family businesses. Lossing says, “they allow the owner, on a tax-advantage basis, to cash out of the business, reinvest the proceeds and defer any tax into the future.”
C.O. (Buck) Horn is Senior Vice President with Bank One’s private client services division in Dallas. Buck can be reached at 214.290.3170 or firstname.lastname@example.org. Carlos Munguia is First Vice President & Manager of Bank One’s commercial banking division in Dallas. Carlos can be reached at 214.290.2833 or email@example.com.